On a previous post, I mentioned how grain prices were being bid up in anticipation of demand for biofuels, and how that was driving a higher land market. Since that post, unprecedented prices have been experienced and near chaos is present in the grain markets. Limit up, limit down moves on consecutive days, to the point where in some cases, the trading floors simply took off the limits. Wild volatility!
To landowners and farmers still holding grain, it has been an interesting guessing game. When do you sell? How much is enough and how high is this going to go? You hate to leave money on the table but you don’t be left holding the bag.
Then there is next year’s crop to worry about. With prices this high, grain producers realise they had best be selling some…..and they have been, and it’s causing problems. When a producer forward contracts grain, the elevator that contracts for it has to hedge the grain on the futures markets. Corn sold on the board at $3.00 triggers margin calls as it goes up. For an elevator contracting hundreds of thousands or even millions of bushels, these margin calls can be huge. In some cases, millions of dollars per elevator! If the elevator doesn’t have that kind of cash, and can’t borrow it, that turns serious fast. Then there is the problem of what to pay for grain on days when the futures market is locked limit down and a trade can’t be made. What do you pay for grain you can’t hedge? In some cases, they are refusing to buy it. Not having an orderly market is not good and again, unprecedented.
As this relates to biofuels, I recently had an occasion to work on a biodiesel appraisal project. What I found was a biofuels market that is somewhat inelastic to price, and the price that sets the tone for biodiesel is the pump price of #2 diesel. At the current price of soybeans, and pump price of #2 diesel, a biodiesel producer is going to lose money on every gallon he produces from soy oil. Consequently, as grain prices took off, most plants simply shut down or converted to lower cost sources of oil that can also be used for biodiesel, namely animal fats. But as for soy oil, even with generous subsidies and tax credits, at current grain prices, it won’t work. So all that anticipated demand for soybean use for biofuels is on hold at these prices. There is demand for traditional uses and there is still an export market for the grains due to the value of the dollar in relation to foreign currencies, but that was not what was said to be driving the grain markets. It was biofuels.
Another large concern is that at current grain prices, the traditional domestic users of grains are being priced out of the market. One I’m aware of is the livestock producers which is the largest domestic user of feed grains. Hogs and poultry are not doing well, and if they shut down, there goes the market for corn, DDG’s from ethanol, soy meal from the soy crush and on and on. Bottom line is it’s not likely that grain prices can be sustained at the high levels they were bid up to in February and March. At these levels, they have priced all their users out of the market.
Long term, the biofuels market is going to be driven by the pump price of petroleum based fuels. Fuel prices are high enough now to bid up grain prices to levels above what has been seen in the previous 15 years or so, but not to the levels they are now. The retail fuels market will buy biofuels when they are competitively priced. So any drop in grain prices below a certain point and the biofuels industry now has the capacity to suck all the surplus grain out of the market. In times of high profit, there isn’t enough grain to produce much more than 20% of our transportation fuel requirements.
So long term, it looks like the grain markets are destined to track the pump price of transportation fuels. Not above, not below, but tracking in an equilibrium pattern. Mandates may come and go, as will tax credits and subsidies, but after periods of correction to account for these, the equilibrium will again be established.
So if I was looking at buying land and intended to pay for it from selling grain, I would not be using $5 corn and $15 soybeans as my long term price, at least for now. The economics of the biofuels industry won’t support it, nor will any other domestic use.
It will be interesting to see if the market agrees with me.
